ArrowMark Financial Corp. (BANX) Q1 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, greetings and welcome to the StoneCastle Financial Corp First Quarter 2017 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rachel Schatten, General Counsel and Chief Compliance Officer. Thank you. You may begin.

Good afternoon. Before we begin this conference call, I would like to remind everyone that certain statements made during the call maybe considered forward-looking statements based on current management expectations that involve substantial risks and uncertainties. Actual results may differ materially from the results stated in or implied by these forward-looking statements. This would depend on numerous factors, such as changes in securities or financial markets or general economic conditions, the volume of sales and purchases of shares of common stock, the continuation of investment advisory, administrative and service contracts and other risks discussed from time-to-time in the company’s filings with the SEC, including annual and semiannual reports of the company. StoneCastle Financial has based the forward-looking statements included in this presentation on information available to us as of March 31, 2017. The company undertakes no duty to update any forward-looking statement made herein. All forward-looking statements speak only as of today, May 4, 2017. Now, I will turn the call over to StoneCastle Financial’s Chairman and Chief Executive Officer, Josh Siegel.

Thank you, Rachel. Good afternoon and welcome to StoneCastle Financial’s first quarter 2017 investor call. In addition to Rachel, joining me today is George Shilowitz, President and Pat Farrell, our Chief Financial Officer. I would like to start the call today with a review of StoneCastle Financial’s quarterly results and portfolio highlights, along with commentary and the company’s relative value and strategic opportunities. Then I will turn the call over to Pat who will provide you with greater detail on our financial results before I open up the call for questions. I am pleased to report that StoneCastle’s total earnings for the quarter were approximately $3 million or $0.45 per share. This was comprised of net investment income of approximately $2.6 million or $0.39 per share and realized capital gains of approximately $391,000 or $0.06 per share. The company’s net asset value per share was $21.32 as of March 31, up $0.10 from last quarter. Total assets were approximately $193 million, with 96% of total assets invested. The estimated annualized portfolio yield was 9.17%, up from 9.08% the prior quarter and up 19 basis points year-over-year. During the quarter, StoneCastle Financial invested $3.8 million in Reliance Bancshares, adding to our current position. StoneCastle also sold the privately held equity investment Pioneer Bancshares for $1.9 million. We realized the capital gain of approximately $443,000, which equates to return of 29% over the cost of this investment. The company also has threefold calls that totaled $7 million and partial calls or pay-downs totaling $5.5 million for the quarter. For derails on the rest of the portfolio, the full schedule of investments can be found on the company’s SEC filings and on the company’s website. Now, I would like to comment on StoneCastle Financial’s relative value in the context of the market. At quarter end, StoneCastle’s estimated annualized portfolio yield of 9.17% was 677 basis points over the 10-year treasury rate of 2.4%. In addition, our portfolio generated a 544 basis point premium over the Bank of America, U.S. Corporate BBB Effective Yield Index as of March 31, which was yielding 3.73% at quarter end. Looking at historical data, we found that credit spreads and banks versus similarly rated corporates are almost the widest they have been in over a decade. Arguably, the relative value of our stock price versus NAV is now even more pronounced with the recent run-off in prices for bank equity investments. Over the past 4 months, we have seen bank stocks move up presumably due to expectations of favorable feature earnings. If this is truly the case, our bank credit spreads are presumably stronger and more stable. In the theory, our investments should be considered more valuable as well. As I mentioned last quarter, several macro considerations are providing tailwinds for the sector, including regulations, interest rates and a continued consolidation of the industry. Further, the adoption of mobile technology has put small banks in a more level playing field with larger banks, all areas that will provide good growth prospects for the industry. For these reasons, we believe it is a great time to invest in community banks and StoneCastle is the only publicly traded investment company dedicated to investing in community banks. On the topic of growth, a larger market cap would have two positive consequences that we would like to discuss. First, we have a pipeline of attractive banks in which to invest and would like to have more cash to deploy. Second, we have had conversations with a number of institutional investors attracted to the stock, but are we left into invest due to our low share trading volumes. They are unable to accumulate meaningful positions without significantly moving the share price and they require increased liquidity. We are actively exploring strategies that would allow the company to grow while maintaining the integrity of the credit quality safety and soundness of the portfolio. As good stewards of investor capital, we take into account a long-term view of our business and protecting shareholder value. One option is to try to close another creative pool transaction to help the sale of pipeline investments. The other is to use our existing $150 million shelf registration in the short-term for private placements of public stock at or above NAV. Investors often ask about the execution of another pool transaction. As I mentioned in the past, executing another transaction requires both originating enough banks in the short time period, while having receptive capital markets. Or stated another way, the ability to execute has just as much to do with market timing as in our ability to source investments. While this sounds like a lot of moving parts, we have successfully done this before. For any new investors on the call, our pool is completed in October 2015 with 35 banks across 24 states. The company retained the preferred shares investing $45.7 million, with an effective yield of 10.49% in an accretive transaction. An important point I want to make is that a pool allows us to obtain valuable 10-year fixed rate term financing. We will keep you apprised of StoneCastle’s progress for a second similarly structured pool. Related to a private offering of public stock, we encourage investors like family offices, financial advisors or institutions interested in the investment objectives of StoneCastle to consider purchasing the company’s shares at or above NAV even today. For yield investors, the transaction should be a compelling way to establish a sizable position without affecting the market price of the stock. To put this into perspective even at the March 31 NAV of $21.32, a StoneCastle investor would earn a current yield of approximately 7%. We believe at the current NAV there is upside and benefit in the price of our stock, because even at $25 per share, an investor would still be earning 200 basis points over the aforementioned BofA BBB index. In conclusion, we continue to explore all options available to us in the capital markets. These examples are not mutually exclusive and we believe we have the ability to execute on these opportunities over time. Now, I want to turn the call over to Pat to discuss the financial results and provide details on the underlying value of the company.

Thank you, Josh. As I do each quarter, I will present the financials by going through the detailed components to help you understand the value of the company. The net asset value at March 31 was $21.32 per share, up $0.10 per from the last quarter. The change in NAV for StoneCastle is comprised of four components: net investment income; realized capital gains and losses; the change in value of the portfolios investments; and finally, distributions paid during the period. Let me walk through these components. Total earnings for the quarter were approximately $3 million or $0.45 per share. Earnings were comprised of net investment income for the quarter of $2.6 million or $0.39 per share and realized capital gains of over $391,000 or $0.06 per share. Net investment income reflects gross income from dividends and interest received from our portfolio investments minus operating expenses. Gross income for the first quarter was $4.5 million or $0.69 per share, up over $305,000. Now, I would like to review the company’s operating expenses, which are comprised of advisory fees, interest expense related to our use of leverage, ABA fees and various other expenses. Net operating expenses for the quarter were $1.9 million or $0.30 per share, up approximately $255,000 from the prior quarter. This increase was primarily due to an increase in interest expense related to increasing LIBOR rates as well as an increase in advisory fees related to the waiver in a previous quarter. The second component affecting the change in the NAV for the quarter is realized capital gains and losses. Net realized capital gains for the quarter were $391,496 or $0.06 per share. This was primarily the result of the sale of Pioneer Bancshares Inc., a position the company held since 2014. This sale generated $1.9 million in proceeds and a gain of approximately $443,000 or 29.5% over the cost of the security. The third component changes in unrealized appreciation or depreciation of the portfolio related to have the value of the entire investment portfolio has changed from the previous quarter end to the current quarter end. For the first quarter unrealized appreciation of the portfolio increased by approximately $105,000 or $0.02 per share. As I noted each quarter, the vast majority of the portfolio continues to be independently marked from broker dealer quotes. For the quarter over 98% of the portfolio prices or marks reflects a minimum of two quotations. These represent the independent third-party assessment of the current value of the portfolio which is used to calculate the net asset value of the company each quarter. At quarter end closing stock price of StoneCastle Financial traded at a discount of approximately 5.5% less than the actual market value of the net assets of the company. The fourth component affecting the change in the net asset value is distribution. Cash distribution for the quarter was $0.37 per share, paid on March 29, 2017 to shareholders of record on March 22, 2017. In summary, we began the quarter with a net asset value of $21.22 per share. During the quarter, we generated net income of $2.6 million, net realized capital gains were approximately $391,000 and the unrealized value of the portfolio investments increased by approximately $105,000. Some of these components offset by a distribution of $0.37 per share resulted in a net asset value of $21.32 per share at March 31. At quarter end, the company had total assets of $193.4 million consisting of total investments of $186.2 million, cash of $3.6 million and other assets of $3.5 million which includes receivables and prepaid assets. Now, let me update you on our credit facility. As of March 31, the company had $52.75 million drawn from the facility. In accordance with the regulated investment company rules, we may only borrow up to 33.3% of our total assets. Our leverage percentage at the end of the quarter was 27.3%. Now, I would like to turn it back over to Josh.

Thank you, Pat. Now operator, we would like to open up the call for questions.

Thank you. Ladies and gentlemen, we will now be conducting our question-and-answer session. [Operator Instructions] Our first question comes from the line of Devin Ryan from JMP Securities. Please go ahead.

Hi, this is Brian McKenna for Devin.

Hi, Brian.

First one for me – hey, how are you doing?

Good.

Obviously, we are still waiting to get the specifics of financial services regulatory reform, but are you seeing anything that would suggest smaller banks might need vast capital than they currently have, which could impact their appetite to raise capital in the foreseeable future or vice versa anything that would drive an acceleration in the need for capital maybe to qualify for an offering?

That’s a great question. There is nothing that we are seeing on the horizon that’s going to allow banks to have less capital. There has been mixed receptions to [indiscernible] banks actually increasing their capital to be exempt from certain Dodd-Frank requirements. So I don’t know if that’s going to go through or not, but we will see. If that were, then there is going to be a rush for more capital. But I don’t see anything on the horizon either internationally nor domestic that would suggest lower capital standards are even on the table.

Okay, got it. And then next, it appears that you still aren’t receiving dividends from the Chicago Shore investment as of March 31, could you just provide us with an update on that investment and if there is any expectation for the dividend to resume in the foreseeable future?

Absolutely. So, their Tier 1 financials were stable to last quarter. They made a small profit. Their non-performings are about the same, which were down last quarter. Capital ratios are slightly up. They are still not completely in line with their directives for capital ratios, so I don’t think it’s going to happen in the immediate term. But we see nothing that gives any cause for concern and degradation of the credit. It’s stable to improving which was the second quarter on a row of profitability. So we are still on a waiting mode. And I would be using a crystal ball if I would forecast when they are going to come back on line.

Sure, okay. That makes sense. And then just finally here, last call you mentioned one way of improving the yields of the portfolio was by negotiating the terms of your debt, is this something you are still looking to do and if so where are you in the process?

Good question. We are actually quite far along in the process. But we haven’t signed documents with the lender yet. We are quite closer, hoping to have it for this call. I would say we have a very confidence level that as you go through, but there is no guarantee. And if so we are not really at liberty at the moment to share. But if it goes through as it’s been negotiated, it’s going to be quite a meaningful savings each quarter in interest expense. So we will hopefully have something for everyone either by the next call or maybe even before if things go well.

Okay, great. That’s it for me.

Thank you. [Operator Instructions] Our next question comes from the line of Christopher Testa from National Securities. Please go ahead.

Hi, good afternoon guys. Thanks for taking my questions. I was just wondering how much in prepayment fees and OID acceleration was there in the quarter, given the significant amount of securities called?

Prepayment fees, very little actually, actually very little for the quarter. It’s approximately maybe $20,0000, very small.

Got it. So what was the primary driver of revenue growth given the portfolio was mostly flat?

It was a full quarter of the investment we put on at the end of the fourth quarter, Baraboo, if you remember that.

Got it, okay.

Right. So we will be closing it at the very, very end of the year, so we had a full year. That was probably the single greatest driver. There are some other ones, but that’s the single greatest driver of the improvement in the portfolio yield.

Right, that was – if I recall correctly it will be 11% or so yield on the term loan?

That’s 10.5%, yes.

Yes. 10.5% got it.

That had closed on December 28, so that’s why such a large component for Q1.

Right, okay, that makes sense. And I am just curious if you guys have seen any change in community banks, obviously the smaller ones being able to access public debt markets in order to raise capital or if they are still kind of locked out from that and relying on specialists such as yourself?

No, nothing has changed on that horizon, smaller banks, especially those that don’t have a public rating from [indiscernible]. They really don’t have much access, outside of folks like us. And at the moment it’s going to be just us. There were some folks who were active long side of us 1 year or 2 years ago that we are not seeing in the market anymore. Actually, they have moved on to other things. They were hedge fund like. So it’s really just us. We do have a decent pipeline. We are short on cash which of course is a challenge. You don’t want to make less of remises to banks are delivering capital, if you don’t have a capital to deliver. So we have been trying to balance the amount of outbound with the amount of cash. So as we mentioned in the call Chris we are exploring ways of trying to raise the capital through a private placement of public stock for folks who have been trying to buy in, because I can’t stress enough even at $23, $24, $25 a share, we are still hundreds of basis points wide to a comparable credit quality index of sort of BBB quality. So we are just trying to find ways to grow the size of the company, so that we can satisfy the pipeline, diversify our exposure for investors.

Right. I agree, I mean the biggest challenge seems to be just being capital constrained, which is just a result of where the public stock trades?

Yes.

And I am just curious, is there any ability on your behalf to have some floating rate investments as well I know that the main source of funding is the credit line which flows – which obviously pressures our NOI with rising rates, just curious if that’s the product that is possible for you to offer and whether it’s better [indiscernible]?

Academically, of course it could, the practical through Chris is the majority of the markets for either bank preferreds switch a less of common and sub-debt is almost all at least within the 5 years, first 5 years fixed rate. I don’t think that’s why it’s loading rate sub-debt in the decade. That said, that doesn’t mean that we can’t either buy an interest rate cap or look at interest rate swap to take some of our credit facility entered into a fixed rate equivalent. So those are things that we are exploring and value [ph] from quarter-to-quarter.

Okay, great, that’s all for me. Thanks for taking my questions.

Sure.

Thank you. Ladies and gentlemen, we have no further questions in queue at this time. I would like to turn the floor back over to management for any closing comments.

Thank you, operator. And many thanks to you our shareholders for listening to the call and we hope you have an enjoyable summer and look forward to speaking to you next quarter.

Thank you. Ladies and gentlemen, this does conclude your teleconference for today. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.